How Ratifying the Kyoto Protocol Will Benefit Canada’s Competitiveness

Executive Summary

A debate is currently raging in Canada about the costs and benefits of the Kyoto Protocol. Opponents of the Protocol claim that Canada cannot afford to ratify, and therefore implement, the Protocol, because it would cause severe economic damage. Prominent in this rhetoric is the notion that the Protocol would damage Canada’s economic competitiveness. “Competitiveness,” however, is defined here in a very narrow, short-term sense. Opponents of Kyoto typically ignore or fail to mention the ability to

save money through increased efficiency;

pass costs on to suppliers or customers;

realize savings and new business opportunities through innovation, and thereby improve Canada’s positioning in both the short and long term;

benefit from policy certainty that will facilitate the planning of future investments; and

address the needs of vulnerable sectors or regions through flexible government policies.

Competitiveness is clearly a much broader concept than opponents of Kyoto would have us believe. This report surveys the real-world evidence of how initiatives to reduce greenhouse gas (GHG) emissions and address other environmental challenges have affected a broad variety of indicators of competitiveness. That evidence strongly supports the following findings:

by taking a lead to address environmental issues, governments position firms in their jurisdictions to be more efficient and competitive in future markets (Chapter 2);

Taken together, these findings provide a sound basis for concluding that Canada’s competitiveness, when defined broadly, is likely to benefit, not suffer, from a decision by the federal government to ratify the Kyoto Protocol.

Government action on the environment can protect and enhance competitivenessThere is a wealth of literature demonstrating that government action on the environment can be a source of competitiveness. According to Michael Porter of the Harvard Business School, a country’s prosperity is created - not inherited from endowments of natural resources - and it therefore depends on the capacity of its industry to innovate and upgrade. Innovation comes from individual firms, but is also fostered by judicious government regulation that reflects the specificities of the country. Porter and van der Linde have demonstrated that properly designed environmental standards can trigger innovation that may partially or more than fully offset the costs of complying with them. While not necessarily accepted by all, Porter’s hypotheses have nonetheless been confirmed by many other studies cited in Section 2.1.

There is a recurring tendency for targeted industries to significantly overestimate the costs of complying with environmental regulations prior to implementation - something Canada’s policymakers should bear in mind when evaluating the current claims that ratification of the Kyoto Protocol will cause severe economic damage. Major initiatives whose costs were significantly overestimated include the Montreal Protocol, adopted to phase out ozone-depleting compounds, and the U.S. Acid Rain Program to reduce emissions of sulphur dioxide (SO2) from fossil fuel-burning power plants. During the negotiations leading to the establishment of the Acid Rain Program, the targeted utilities argued strenuously that the Program would jeopardize their competitiveness. Estimates of marginal compliance costs and allowance prices were in the range of $300 to $1,000 per ton of SO2. In comparison, a typical SO2 allowance price in 2000 was $150 per ton, while electricity prices remained stable through the 1990s. Innovation was of key importance to the success of the Program.

The early development of the U.K.’s GHG emissions trading system, which began formal operation in April 2002, and the proactive role played by British industry in setting it up underline the fact that other countries are already moving ahead of Canada to set up regulatory regimes for GHGs that will advantageously position their firms for the future. The industrial sector in the U.K. pushed for the development of an early regulatory framework for GHG emissions in order to prepare itself to meet the country’s Kyoto target on time and gain a strategic competitive advantage by being ahead of the game and able to build on and export new knowledge. In June 2000, the Confederation of British Industry stated that “business . . . continues to be involved in numerous activities which will help ensure that the U.K. meets its international commitments . .

The Government’s attempt to promote a transition towards a low carbon economy has the potential, if properly framed, to establish the basis on which the U.K. could reasonably meet further commitments above and beyond those agreed at Kyoto.”

In sum, governments that take a lead in addressing environmental issues position firms in their jurisdictions to be more efficient and competitive in future markets. Canadians therefore have good reason to be concerned that a failure to ratify the Kyoto Protocol may condemn Canada to fall further behind jurisdictions in Europe and elsewhere who are ratifying the Protocol - not just environmentally, but also in terms of competitiveness.

Protecting and enhancing competitiveness: A policy design issue

While there is a lot of evidence that regulatory environmental initiatives can enhance competitiveness, it is obvious that this depends to at least some extent on the design of the initiatives in question. According to Porter and van der Linde, “properly designed” regulation is regulation that motivates firms to innovate, since innovation is the fundamental driver of competitiveness. These authors list eleven criteria for innovation-friendly regulation (see Section 3.1). It is striking how well a “cap and trade” emissions trading system - the central policy instrument envisaged by federal and provincial governments in Canada to reduce GHG emissions from large industrial emitters under the Kyoto Protocol - satisfies these criteria, while giving governments essentially unlimited flexibility in addressing regional and sectoral vulnerabilities.

Environmental taxes are another policy measure that can satisfy Porter and van der Linde’s criteria. Over the last decade, numerous European governments have implemented broad based ecological tax reform policies. These policies do not seek to increase the overall tax burden but rather to increase or implement new environmental taxes - mostly carbon or energy taxes adopted primarily with a view to reducing GHG emissions - while simultaneously reducing other existing kinds of taxes. Depending on which taxes are reduced, substantial economic modelling research cited in Chapter 3 has predicted the potential for increased competitiveness in the form of employment gains as a result of reductions in payroll taxes, or increased domestic spending and investment as a result of reductions in capital or income taxes.

Other key policy measures that could help Canada to make major GHG emissions reductions, such as renewable energy portfolio standards (requiring electricity retailers to source a minimum percentage of electricity from low-impact renewable sources) and fuel efficiency standards for road vehicles, can also meet Porter and van der Linde’s criteria. In other words, with good policy design, the Kyoto Protocol can be implemented in Canada in a manner that protects and enhances competitiveness.

Corporate action on the environment enhances competitiveness

Leading firms worldwide are embracing environmental responsibility for competitive advantage. The strategy is simple: by being a leader in environmental protection, the firm is driven to be more innovative and create additional value for its customers and shareholders. One of the most important competitive advantages for environmentally leading firms is the identification, development and commercialization of new business opportunities. Substantial research completed by the top business schools in North America and cited in Section 4.2 establishes the link between corporate competitiveness - both in terms of innovation and the ability to attract and retain the best employees - and environmental leadership.

An in-depth study of corporate action on reducing GHG emissions by Russell and Margolick demonstrates that an increasing number and variety of major U.S., Canadian and global firms have taken on significant GHG emission reduction targets. The authors find that the primary reason the corporate sector is taking on GHG reduction targets is competitiveness: “All of the companies see targets as improving their competitive market position by reducing production costs and enhancing product sales today, and in anticipation of regulatory and market environments of the future.”

There is an abundant literature demonstrating corporate examples of saving money and becoming more competitive by implementing innovative environmental initiatives. Table 1 in Section 4.3 provides details of the initiatives of nine large firms with major operations in Canada, drawn from the oil and gas, electricity, chemicals, transportation and manufacturing sectors. These firms have successfully positioned themselves to reduce GHG emissions in anticipation of Kyoto ratification by adopting reduction targets that meet or exceed Kyoto levels. Highlights include the following:

BP, by March 2002, had reduced global GHG emissions to 10% below 1990 levels at no economic cost, while basic earnings per share increased from $0.17 in 1998 to $0.36 in 2001;

Suncor has committed to lowering GHG emissions (net of offsets) to 6% below 1990 levels by 2010 if Canada ratifies Kyoto and plans to invest $100 million by 2005 in alternative and renewable energy projects; revenues increased from roughly $2 billion in 1999 to $4 billion in 2001;

in DuPont’s global operations, from 1990 to 2000, energy use remained constant, production increased by 10% and GHG emissions were reduced by 60% while the shareholder return increased fourfold; á between 1995 and 2001, Interface (flooring products) reduced GHG emissions per unit of production in its Canadian operations by 64% while the company’s waste reduction program produced savings of over $185 million worldwide.

Implementation of the Kyoto Protocol in Canada will provide rewards for these leading firms for their early action. On the other hand, the federal government’s continued hesitation on ratification creates “policy uncertainty” that is harmful and costly for corporate decision making and competitiveness. A decision not to ratify would simply prolong this uncertainty given that Canada will not be able to avoid eventually participating in a global agreement to reduce GHG emissions.

Kyoto will create corporate business opportunities

Addressing global climate change through the Kyoto Protocol and subsequent agreements will also create opportunities for new firms to satisfy the ever-increasing demand for low-GHG technologies. There is already substantial growth in innovative new firms in Canada that are emerging in anticipation of the need for GHG reductions. Opponents of the Protocol tend to focus on the threat to established firms that have not positioned themselves well for GHG reductions while ignoring these emerging sectors that will benefit. While the drive to reduce GHG emissions will undoubtedly create many unforeseen business opportunities, the following three key emerging sectors will clearly benefit from the Kyoto Protocol.

Low-impact renewable energy. Under a Kyoto implementation scenario investment in windpower facilities in Canada could be worth up to $6.5 billion by 2010. Hesitation over Kyoto is currently keeping Canada behind our competitors (including the U.S.) in windpower.

Alternative transportation technology. Major firms such as Shell International and DaimlerChrysler expect hydrogen to emerge as the world’s primary energy medium and fuel cells, especially in vehicles, to play an integral part in the hydrogen economy.

Energy efficiency technology. Under a Kyoto implementation scenario, an estimated $21 billion could be spent on energy efficiency measures in Canadian buildings by 2010.

The following firms are examples of small but rapidly growing Canadian companies positioning themselves to be competitive in a Kyoto implementation scenario. Canada’s ratification of the Kyoto Protocol will assist these firms and similar ones in bringing new and improved products to the domestic market, enhance their ability to become significant exporters of Canadian technology, and provide an incentive for them to stay in Canada:

Ballard Power Systems, Inc., based in Vancouver, is a world leader in the development of fuel cells in automotive applications. Ballard is the fuel cell engine provider of choice for many major vehicle manufacturers. DaimlerChrysler and Ford equity ownership of Ballard recently stood at 23.6% and 19.5% respectively, investments worth hundreds of millions of dollars.

Iogen Corporation, based in Ottawa, has developed a new enzyme-based technology to produce ethanol - for use in ethanol-blend gasoline that can be used in all modern cars - from straw, an agricultural byproduct. To date, Iogen has received a $15.8 million investment from Petro-Canada and a $US 29 million investment from Shell.

Financial markets reward environmental leadership

A further important category of evidence for the enhanced competitiveness of firms that are environmental leaders is provided by the financial markets. A recent report by Innovest Strategic Value Advisors, a New York-based investment research firm, argues that the linkage between environmental performance and competitiveness will be especially strong with respect to corporate performance in addressing climate change. Integrating climate change into business decisions demonstrates a good risk management strategy, rewarded by the market. Numerous other studies demonstrate that financial markets reward firms that are environmental leaders. For example:

In every sector rated by Innovest using its “EcoValue 21” rating system for environmental performance, companies receiving above average EcoValue 21 ratings outperformed below average companies by 300 to 1800 basis points, as measured by total stock market return.

Since its inception in May 1990, the Domini Social Index (DSI) has outperformed the Standard & Poors (S&P) 500 index. As of June 30, 2001 the DSI had recorded an annualized return of 16.3% over a 10-year period, compared with 15.1% for the S&P 500. On a five-year basis, the DSI had recorded an annualized return of 15.6%, compared with 14.5% for the S&P 500.

In Canada, the performance of 60 of the most socially and environmentally responsible firms can now be tracked with the Jantzi Social Index (JSI), established in January 2000. Return rates have regularly been comparable or superior to standard indices such as the TSE 100, the TSE 300 or the S&P/TSE 60. The JSI dropped less on September 11, 2001 than those three standard indices.

A closely related line of evidence shows that investors are increasingly demanding that firms meet high standards of environmental and social performance. According to a detailed study by the Social Investment Forum, there are now 230 mutual funds in the United States that incorporate social screening into the investment process, compared to 168 in 1999, 139 in 1997, and just 55 in 1995. According to the same study, the value of socially or environmentally screened portfolios in the U.S. in 2001 was $2.03 trillion compared to a total of $19.9 trillion of professionally managed U.S. investment assets. Another study reported that 26% of U.S. investors say that the business practices and ethics of a company are extremely important to their investment decisions.

A study conducted by Canada’s Social Investment Organization shows that in mid-2000, socially or environmentally screened investments in Canada were worth almost $50 billion. The retail market for such investments grew by 75% between June 1998 and June 2000, more than twice the growth rate of the Canadian mutual fund market as a whole.

Conclusion

To re-iterate, this report surveys the real-world evidence of how initiatives to reduce GHG emissions and address other environmental challenges have affected a broad variety of indicators of competitiveness. That evidence strongly supports the following findings:

by taking a lead to address environmental issues, governments position firms in their jurisdictions to be more efficient and competitive in future markets;

governments can design policies in a manner that respects legitimate competitiveness concerns; á firms that take action to improve efficiency and reduce GHG emissions also improve their competitiveness;

major business opportunities are being created for innovative firms as a result of Kyoto; and á financial markets reward firms that are environmental leaders.

Taken together, these findings provide a sound basis for concluding that Canada’s competitiveness, when defined broadly, is likely to benefit, not suffer, from a decision by the federal government to ratify the Kyoto Protocol.